Friday, 28 January 2011

"Crash & Burn" Dairy Farmers &/or Bankers go Mad

NZ & in particular Christchurch & Canterbury have been hit by more than 4000 after shocks since Sept 4th 2010 when there was a massive earthquake measuring 7.1. The damage in the city & on some farms has been dreadful & heartbreaking for families involved. See the photo where the road, hedge & fence moved in excess of a metre during the big one in Sept.This isnt the only quake to hit NZ.NZ dairyfarmers have gone mad & paid rediculous money for cows & land now both have crashed & some dairyfarmers will burn! Two years ago land prices in NZ got up to NZ$70 per kg of Milk Solids (the way land is often valued in NZ) today they are max NZ$40 & some farms are selling nearer to NZ$20. Two years ago dairy cows peaked at NZ$2000 today they are less than NZ$1400. Why? They went mad thats why! With total disregard for cashflow/profit or decisions based on commonsense some have made crazy investment decisions! Land was never worth NZ$70 & cows were never really worth NZ$2000. The mad crazy market drove the prices beyond what they really were worth. In areas like Canterbury there are hundreds of farms with massive new rotaries & brand new irrigation systems (centre pivots)...the capital spending is extraordinary. The capital works look impressive but the debt now looks very scarey!The milk price didnt drive farm prices higher, the profitability of NZ farms didnt justify the extreme prices or massive capital spending......so why!!

The expectation was that land prices would forever continue to rise.....so farmers started to speculate & to farm the gain in speculative gains(increases in equity & borrowing against non real equity gains). Who supported this madness....the bankers!!!

The bankers carry much of the responsibility for the very risky lending on non existant profits & on unreal capital gains. Many farm purchases were not based on sound economics or profitability. Does this sound like Ireland? The banking crisis has hit dairyfarmers or is about to....big time!?

On our recent NZ study tour we met one young dairy farmer who bought a farm 2 yrs ago with 50% equity (based partly on cows worth NZ$2000) today that same farmer has equity of 23% & is hanging on by his finger nails. This is frightening stuff!

Now the Australian owners of the NZ banks are saying enough is enough. They are calling in much of the excessive farm debt. Farmers are getting calls demanding in some cases up to $500,000.

Now where do you get that sort of money if all banks are taking the same line???

The "Crafar case" is a very public example of the inevitable increase in farm bankruptcies.

Everyone is expecting the number of "crash & burn" dairyfarms & farm businesses to increase in NZ.

Nicola Shadbolt & partner Shane Carroll refocussed our visiting French group (from Brittany) back to the basics. Nicola emphasised the importance of profit & cash. Benchmarking in Discussion Groups must focus on the right profit ratios & on cashflow. Profit per hectare is insufficent & very risky.

A strong cashflow business can capture purchase opportunities (farms or farm business expansion)but in doing so must not lose sight of profit, return(& profit) on equity & cashflow must be strong going forward. If there are NZ farm businesses that are going to "crash & burn"....believe me there are others who have kept focussed on cashflow who will now await their opportunities. Dont get swept along with the madness of a gold rush! Cash is King!Keep focussed on cashflow & profit.

3 comments:

Tom,I would be one of those Canterbury dairy farmers you refer too who has done the impressive capital development and has a scarey amount of debt ( your words not mine).

Sure there are a small number of farmers who went a step too far financially and/or did not have the capability to manage their business effectively. However I would dispute your suggestion that ridicules money was paid for cows and land. That depends on your long term view of milk price and interest rates and what is a satisfactory return on capital for a dairy farm in Canterbury.

In the area I farm the top priced farm sale was $50000 per hectare for a cropping farm purchased by a vegetable grower. At the same time land on not as good soils but just as suited to a dairy conversion was selling for $35000 - $40000 per hectare. In 2007 I converted a 325ha cropping farm to a dairy farm at a cost of $8000/ha, nothing too scary about that. Add Fonterra shares $7000/ha and stock at $8000 per hectare and machinery at $1000/ha and you have an all up cost at the peak of the market of $59000 to $64000 per hectare for a property that would produce 1500 milksolids per hectare.

That sort of farm can comfortably be run with farm working expenses of $4.00 per kg milksolids, sharp operators would have a lower cost structure and/or higher per hectare production. At a $7.00 Fonterra payout that leaves $3.00 surplus or $4500 per hectare giving a return on assets of between 7% and 8% pre tax. Not too bad comopared with other investment choices in my humble view.

On current asset values the return on assets is more like 10%. I think that is too high and expect asset values to rise significantly if the milk price stays around current levels.

Tom, to convince me that I and a lot of my farming contemporaries paid too much for assets in the past you need to put up a compelling argument for a significantly lower long term milk price for NZ dairy farmers.

Tom thank you for yr detailed comment. I hear what you are saying but some of what I am seeing in NZ agriculture is frightening stuff.5 years ago when I was regularly working in Ireland...I heard about the amazing returns from investing in housing. The credit cruch has ripped the guts out of Ireland & especially property values. Many who borrowed & invested in the bonanza have lost big time!In NZ it isnt so much the milk price its the credit squeeze after land & cow values have dropped so dramatically leaving farm businesses with very little equity.Watch the wine industry where grape prices were $2400/t now they are approx $1000/t. Those with massive borrowings are now threatened with losing their businesses.Watch the mussel farm businesses...prices were $1500/t now they are approx $500/t. Those with massive borrowings in businesses that are over capitalised now risk losing their businesses.Dont worry.....those with low cost simple businesses with good cashflow management who are cash strong will now circle like vultures & be able to buy in at barginbasement prices.There is a credit crisis looming for many....beware the bankers who were so generous some months ago!Tom in my view many/some NZ dairyfarmers have been lured into high cost systems that are capital expensive....have they borrowed against inflated equity????? Maybe!NZ has developed a very good low cost simple system based on pasture...sadly some have lost sight of the strengths of a pasture based system with low costs.Thank you for your contribution to an important debate.Tom Phillips

About Me

Tom Phillips proudly a Kiwi. I'm based at the New Centre of Excellence in Farm Business Management, Massey University, New Zealand.The Centre is a joint project of both Massey & Lincoln Universities. International Low Cost Pasture based Dairy Industry Consultant has worked in New Zealand, Australia, Taiwan, United Kingdom, Ireland & France.Expert in grazing management & dairy farm business management,Onfarm Discussion Group facilitation & training.
I am a strong advocate for pasture based dairy farming partly because it is environmentally & animal friendly with a low carbon footprint but also it creates a profitable strong business which is family friendly.